An Income Stock Hidden in Plain Sight

Investors tend to overlook companies in sectors that don’t come to mind readily, but that doesn’t mean there’s a reason to search out the lesser-known income stocks, writes Josh Peters of Morningstar DividendInvestor.

Bemis (BMS) is a little-known company, yet its products are ubiquitous and in steady demand.

Flexible packaging may seem bland compared with the well-known brands that are printed across it, but this firm earns double-digit returns on invested capital, and has paid dividends each year without interruption since 1922.

Bemis competes with many other firms in the flexible-packaging industry, including Sealed Air (SEE), Sonoco (SON), and Winpak. Bemis’ strong material-science portfolio allows it to develop unique packaging products that extend shelf life, enable easy opening and closing, and provide for vibrant graphics on the package.

These value-added features have allowed Bemis to enjoy double-digit operating margins in its flexible-packaging division for more than a decade. The smaller pressure-sensitive material segment is less profitable, but makes up only 10% of sales.

The Dividend: What’s New?
The safety of Bemis’ dividend remains attractive. Total debt of $1.4 billion on March 30 is manageable in the context of operating cash flow that we expect to exceed $400 million in 2011 and $500 million or more thereafter.

Based on management’s most recent profit outlook for this year, the dividend-payout ratio should fall close to the midpoint of the firm’s long-term target of 35% to 45% of earnings.

As for dividend growth, February’s increase of 4.3%—to 96 cents a share on an annualized basis—marked a 28th straight year of higher dividends, as well as an improvement on the low 2% hikes of 2008 and 2009.

In the nearly six years that Bemis has been part of the Builder Portfolio, only once (2007) has the stock met or exceeded our long-run projection for average annual dividend growth. Yet while Bemis reduced its outlook for 2011 earnings by 7.5% in April, to between $2.15 and $2.30, we believe it is capable of improving its growth rate going forward.

We think wild fluctuations in commodity prices and economic weakness are more to blame for Bemis’ recent results than a loss of competitive strength or long-term customer demand. Historically, Bemis’ gross margins have been relatively steady, thanks to contracts that frequently permit price changes in line with commodity-input changes.

Resin price shocks were typically followed with price changes in a month or two. However, the customer base that came with Bemis’ March 2010 acquisition of Alcan’s plastic-packaging business brought longer lag times embedded in multiyear contracts, and it will take a few years to rework these contracts as they come up for renegotiation.

We expect good things from FreshCase, a new and innovative form of packaging for fresh beef that extends shelf life without hurting quality. Customer testing of this new product is occurring during the first half of 2011, and potential rollout of the solution could happen in late 2011 and early 2012.

Currently, most of Bemis’ meat packaging centers on processed meats, so FreshCase is poised to poach sales from competitors rather than from existing Bemis products.

In all, we forecast Bemis’ future dividend growth to run at roughly 7% to 8% annually. This outlook is predicated on revenue growth of 4% to 5% a year, stable profit margins, and a modest contribution to per-share expansion from share repurchases.

A purchase at our buy price of $28 would provide a current yield of 3.4% and the prospect of average annualized total returns of about 11% over the long run. [The stock recently dropped into this area, closing just under $30 on Tuesday—Editor.]